Stephen Bruce, Director, Portfolio Management and Head of Research, Perennial Partners shares his thoughts on the market, where it’s headed and his top investing tips and stock picks.

IV: Where do you see strong income opportunities in 2022?

Stephen Bruce: The post-COVID recovery will see earnings bounce back strongly across most sectors of the market in 2022.

The major banks are seeing improving credit growth and benign credit conditions and, when you combine this with the strong capital positions they are in, they are well placed to pay attractive dividends in the coming year.

The large-cap end of the resources sector should also be a good source of dividends, despite the fall in the iron ore price. Even factoring in significantly lower long-term iron ore prices, these stocks will still be generating strong cash flows. Combined with their ungeared balance sheets, they will be able to continue to provide high levels of dividends to investors.

The insurers are also generally well-capitalised and facing into an improving earnings environment, which should be positive for their dividend paying prospects.

IV: How has asset allocation and risk management changed in the last 12-24 months?

Stephen Bruce: Markets have rallied strongly from their lows in March 2020, with investors factoring in a return to growth as economies reopen, supercharged with stimulus, and supported by low interest rates. All this has seen parts of the market come to trade on very stretched valuations.

For example, growth-oriented sectors such as technology and healthcare are at record multiples. This increases the level of risk associated with these stocks and makes them vulnerable to being sold off should their outlook deteriorate or if interest rates begin to rise.

By contrast, the more cyclical parts of the market are trading on more reasonable valuations as well as providing greater leverage to the reopening of the global economy. As a result, in our view, being weighted towards these kinds of stocks at this point in the cycle provides both greater upside potential as well as reduced downside risk.     

IV: Your top three tips on how investors should position their portfolio

Stephen Bruce:

1. Don’t overpay for stocks – no matter how good you think a company is, there is a price at which it is no longer a good investment.
2. Pay attention to balance sheets – companies with weak balance sheets can quickly find themselves in  financial distress and this is the quickest way to lose your money.
3. Be contrarian – the best opportunities are often found in the least popular parts of the market

IV: Your top three stock picks and why?

Stephen Bruce:

1. Macquarie Group – Volatile markets and strong demand for infrastructure assets puts the group in a good place to upgrade earnings over the coming year
2. Aristocrat Leisure – Rapid growth in their online gaming business is likely to see them surprise on the upside at their coming result
3. Kathmandu – This retailer has struggled during lockdowns but is well placed to benefit from the reopening and resumption of travel

IV: Sectors and stocks to avoid and why?

Stephen Bruce:

1. REITS – Structural revenue pressures, for example online shopping impacting malls and work from home impacting office demand, plus sensitivity to rising interest rates, keeps us away from this sector.
2. Utilities – Increased regulatory pressures and the risks stemming from the energy transition mean that these companies are in the “too hard” basket at the moment.
3. Tech – Yes, many of these companies are exciting, with plenty of blue sky potential, but in a broadly recovering economy, with rising interest rates, their valuations may come under pressure.